What Is Real Estate Crowdfunding?
Crowdfunding means pooling money together from a group of people — the “crowd” — who have a common goal. There are 4 main types of crowdfunding: donation, reward, equity and debt. It can be financing a new project or business or even supporting someone who needs a medical treatment. Typically crowdfunding is done via the internet using platforms like Kickstarter, Indiegogo or Make A Wish (non-profit).
Crowdfunding was always a logical distribution channel for real estate investments and existed for a long time in the form of hard money lending. Individuals were asking someone they knew (friends, family or professional network) for money to complete a project. With the passage of the Jumpstart Our Business Startups Act in 2012, many of the barriers that previously existed for investors in real estate were removed. You no longer had to know someone who knew someone to find a project to invest in, but could now find many projects sourced from different sponsors on websites.
Real Estate Crowdfunding and the JOBS Act
Jumpstart Our Business Startups Act (“JOBS Act”) was signed by President Obama in 2012 and established new guidelines on how businesses could raise money through crowdfunding. In short, it made the process faster and simpler. After the law’s passing, real estate developers could use crowdfunding to fund their projects.
Types of Real Estate Crowdfunding.
Real estate crowdfunding can be both equity and debt. In an equity investment scenario, the investor is a shareholder in a specific property while in debt they act as a lender.
This chart summarizes key differences between equity and debt real estate crowdfunding investments:
| Debt | Equity | |
|---|---|---|
| Type of investment | Lender to Property Owner | Property Owner (shareholder) |
| Return | Interest (Fixed) | Share of net profits (Varies) |
| Return Potential | Capped, limited to the loan interest rate | Uncapped, can be in the double-digits |
| Risk | Lower | Higher |
| Secured by | Payback of loan is either (1) secured by the property or (2) unsecured promisory note | Unsecured-You own real estate value after debt |
| Seniority Default | 1st to receive payout, but you may have to pay some of the foreclosure costs if loangoes into default | 2nd to receive payout |
| Distributions | Yes, monthly or quarterly interest payouts | Varies, sometimes quarterly distributions are paid |
| Fees | Typically 2% + possible loan origination fee | Typically 1%–2%, no upfront or service fees |
| Holding period | Varies: 6–24 months | Varies: 1–10 years |
| Tax benefits | No | Yes, investors can tyypically take the depreciation deduction without owning the property directly |
(Source Investor Junkie)
Who Can Invest?
Initially, only accredited investors could participate in real estate crowdfunding. For an individual to qualify as an accredited investor, one of two conditions must be met:
- net worth or joint net worth with the person’s spouse exceeding $1,000,000 not including the value of the primary residence.
- annual income of $200,000 in each of the two most recent years, or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income in the current year.
In October 2015, the SEC finalized its ruling on Title III of the JOBS Act allowing non-accredited investors to participate in some crowdfunding investments through provisions under Regulation A.
Benefits for Investors
Portfolio diversification
Real estate crowdfunding allows investors to diversify their portfolio by investing in the real estate market which tends to be less volatile than stock market and reduces the potential of significant losses from market cycles.
Liquidity
Investors can find many different forms of real estate loans that fit their investing horizons, from short-term fix and flip loans to longer-term commercial mortgages.
Transparency
Investors have access to more information (compared to REITs) to be able to better evaluate opportunities.
Small minimums
Previously to invest in real estate deals, investors usually had to put up a minimum of $100,000 to invest in a project, but crowdfunding has helped to reduce that, with some platforms allowing investors to participate in a project with an initial investment as small as $1,000.
Taxes
For equity deals, you can potentially deduct expenses from your annual income tax. You should also be aware of the benefits of depreciation in real estate crowdfunding. As with all investments, it’s a good idea to consult with your accountant or Tax professional before investing!
Conclusion
Real Estate Crowdfunding solved a lot of problems for both investors and developers.
Problems Being Solved
| Deal Sponsors / Developers | Investors |
|---|---|
| High Costs | Minimums are way too high |
| Tough to get access to capital | No access (“country club” deals) |
| Banking restrictions (Dodd-Frank | Only local exposure |
| Too small for institutional investors | Massive fees for REITs |
| Banks are too slow | Lower returns |
| Murky information |
Real Estate Crowdfunding is a great opportunity to diversify your investment portfolio and may provide a steady stream of income to help supplement your current income, fund your next startup, fund your retirement, or fund your next adventure.
Want to learn more about real estate crowdfunding? Read our tips for accredited investors.
