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:
Type of investment
Lender to Property Owner
Property Owner (shareholder)
Share of net profits (Varies)
Capped, limited to the loan interest rate
Uncapped, can be in the double-digits
Payback of loan is either (1) secured by the property or (2) unsecured promisory note
Unsecured-You own real estate value after debt
1st to receive payout, but you may have to pay some of the foreclosure costs if loangoes into default
2nd to receive payout
Yes, monthly or quarterly interest payouts
Varies, sometimes quarterly distributions are paid
Typically 2% + possible loan origination fee
Typically 1%–2%, no upfront or service fees
Varies: 6–24 months
Varies: 1–10 years
Yes, investors can tyypically take the depreciation deduction without owning the property directly
Portfolio diversificationReal estate crowdfunding allows investors to diversify their portfolio by investing in the real estate marketwhich tends to be less volatile than stock market and reduces the potential of significant losses from market cycles.LiquidityInvestors 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.TransparencyInvestors have access to more information (compared to REITs) to be able to better evaluate opportunities.Small minimumsPreviously 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.TaxesFor 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!
Real Estate Crowdfunding solved a lot of problems for both investors and developers.
Problems Being Solved
Deal Sponsors / Developers
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
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.
Disclosure: All data presented here is for demonstration purposes only. Past performance is not indicative of future returns. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. Investors should consult with their own legal, financial, and tax advisors. While AlphaFlow strives to make the information in the article as timely and accurate as possible, AlphaFlow makes no claims, promises, or guarantees about the accuracy, completeness, or adequacy of the contents of this article, and expressly disclaims liability for errors and omissions in the contents of this article.
Hard Money Lending has been around for as long as real estate investing has existed. In its earliest form, Hard Money Lending was just an individual asking someone they knew for money to complete a project. Over time, these individuals evolved into small lenders, pooling several investor’s capital. Not too long after, private equity type firms with access to deep pools of capital became interested and started lending. After the JOBS Act in 2012, some real estate investors realized there was an opportunity to get individual investors more involved by bringing more transparency and the ability to diversify by buying parts of many different loans through online platforms. AlphaFlow takes the best aspects of working with a large group (like a private equity group) and online platforms by combining the deep knowledge of a private lender and the transparency and diversification offered by crowdfunding. Join us for a deeper tour of the history of Hard Money Lending!
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If you are a real estate investor, you have no doubt heard about the benefits associated with crowdfunding real estate deals. It’s not hard to see how the system is setup to benefit investors and entrepreneurs. It provides easy access to investors who can provide the capital you need to make your next project work, and it also provides a framework for repayment that is easy to understand and manage, which would not have been possible when dealing with a large number of investors even fifteen years ago. This makes crowdfunding for real estate very efficient and easy to manage for even smaller investors.
Understanding How Crowdfunding Real Estate Investments Work
If you are interested in backing real estate projects, crowdfunding platforms provide you with an easy way to connect to developers with investment opportunities. Crowdfunding is relatively easy to participate in, too. Investors simply sign into the crowdfunding platform to navigate through various projects. The research about the property development and the prospectus are available, and there are usually various levels of involvement with projected investment returns. There are certain platforms that provide a means for developers to independently present opportunities. In this case, the platform provides a variety of tools and features to customize the offering, including the returns being offered. Other platforms will work directly with the developer as the direct financing partner. These platforms will be responsible for presenting the investment offering to prospective investors.During the crowdfunding period, investors buy into the project for various amounts, securing their portion of the investment. One needs to understand the project’s terms and the ways they work to understand the tax implications of investing. That’s because the structure of the crowdfunding real estate opportunity and the exact rules of the platform can affect the way you realize the gain from your investment, changes to the way you get paid and affects the way you report that gain for tax purposes. A number of factors determine how you need to report income taxes, so it is important to consider all of them before investing.
Accredited Investor Crowdfunding Real Estate Tips
Here are the major aspects you need to consider as you plan your first crowdfunding real estate investment. It’s vital to know all of this before committing to any deal because your tax planning and income management are going to depend on it.
What Kind of Deal Do You Have?
Is this an equity arrangement or are you financing a loan? The income from them is vastly different, both in the timing of its delivery and in its size. Depending on your platform, you might see interest payments every quarter or every month throughout the payment period if you are backing a loan. These earnings represent income from the interest that is paid on the loan and your original investment amount – the principal – will be returned at the end of the loan period. If it is an equity deal, though, then you are unlikely to see any income until the property is sold or until it begins to lease to tenants, depending again on the nature of the investment. If the property is sold, you can plan on a lump sum in one tax year. If you receive interest, then you will have a smaller tax burden each year, but you will have to plan on paying taxes on the investment every year.
K-1 Vs. 1099 Reporting
Schedule K-1 is the income reporting schedule used to report partnership income, and it is filed by each partner. Some people wonder whether or not this is the proper way to report income from crowdfunding investments. The answer is that it is, under the right circumstances. If you enter into a formal business partnership with other investors and then back a project, you would report your portion of the partnership income on a K-1 form.Generally speaking though, when you buy into a crowdfunded investment, it isn’t like forming a partnership with friends or family and investing together. It’s more like you purchase shares of a loan, and then you receive a payoff in the form of interest earnings paid regularly over time, and a lump sum of your initial investment amount when the loan is repaid. That interest income would be reported as general income on a 1099-INT form, similarly to the way you would report other investment income.
Using A Self-Directed IRA
Individual retirement accounts can be used for investment purposes if you wish, and the taxes are deferred until the money is withdrawn at retirement. The benefit of a SD-IRAis that you can invest in many opportunities, such as crowdfunding or private equity, that are not available to normal retirement accounts, like a 401K or a regular IRA. The downsides are multiple, but they are often worth the trouble for investors:
You can’t withdraw funds until retirement
You can’t involve your spouse or companies that you have more than a fifty percent interest in
It takes a lot of work
Each IRA, even those that are self-directed, must be held by a custodian. This can either be a credit union, bank, trust company or a licensed non-bank custodian. Taking time to research and ask questions when looking for a custodian is one of the ways you can get the most benefit from your investment.The advantages are almost limitless, though, because by self-directing your IRA investment, you can put your money into the investments you choose, allowing you to grow your money as quickly as your skill lets you.Take some time to learn all about the tax implications of real estate crowdfunding in our free eBook before you start investing.As of the printing of this article the Federal Reserve had raised its benchmark lending rate a quarter point. There are an additional two rate hikes projected by most analysts for 2017. While the increased rate hike is an indicator of a strengthening economy, what do higher interest rates augur for commercial real estate investment trends and how do investors evaluate the rate hike vis a vis their investment portfolios? Here are a few subplots as interest rates march upward.Rates rise in response to good news. It’s important to keep in mind that the anticipated rate hikes are in response to sustained GDP growth, improved consumer confidence, healthy job creation forecasts, and employment settling at or near capacity levels. After moving cautiously for years, the Fed’s hints of rate hikes mean a robust conviction that the economy has made a full recovery, and is operating at or near productive capacity. From this standpoint, CRE investors should not be too disheartened by looming rate hikes; strong rental housing demand, a healthy retail sector, and stimulus in manufacturing should help grow demand for all types of commercial real estate.
An eye toward secondary markets. As Fed Chairman Janet Yellen noted during her February meeting with the Open Market Committee in February, there are some concerns of frothiness in high-density core markets, where inpouring of foreign investment and a glut of supply continue to compress cap rates. With a rising cost of debt capital, it may become more critical than ever to pursue opportunities in non-gateway cities. Fortunately, there are a handful of secondary markets – such as Austin, Denver, and Seattle – experiencing above-average overall population growth, driven by an influx of millennial professionals who will drive multifamily, retail, and office demand for the foreseeable future.
Watch for Movements in the Regulatory Environment. With Republicans in control of the executive and legislative branches, the future of several Dodd-Frank-era regulations are in question. In particular, the rule requiring commercial mortgage-backed security issuers to retain five percent of the credit risk on issued securities. Should this rule stand, traditional lenders may be constrained, compounding the increased cost of debt capital stemming from rising rates. This could expand opportunity for hard money lenders and yield more margin opportunities for real estate crowdfunding platforms and their investors.
With higher interest rates, inflation becomes a wildcard. While rising rates typically have the eventual effect of tempering inflation, it’s likely that the underlying growth and consumer confidence driving the Fed’s decision will also mean higher rates of inflation in the short and medium term – growth and a relatively high velocity of money should push prices up in the short term before monetary policy reins in growth and inflation. CRE investors should keep a close eye on price movements. Managers should be ready, able, and willing to push rents upward in response to rising interest rates and inflation. Flat long term leases are suboptimal in this environment, and won’t create as much value on a relative basis.
What About Cap Rates? There’s a common misperception that cap rates and interest rates move in lockstep – in other words, that rising interest rates will have a negative effect on pricing and increase cap rates, ceteris paribus. While it’s true that cap rates and interest rates (using 10 year treasury yields as a proxy) show a modest correlation of 0.7, correlation does not imply causation – cap rates are influenced by a wider network of variables beyond interest rates, including real estate market fundamentals, investor appetite for risk, and capital flows.
The more critical takeaway is that any corresponding increase in cap rates stemming from an interest rate hike (as consequence of increased cost of capital) is likely to be mitigated over time. The effect of an increased “exit cap rate” on return diminishes over time, as the compounding effect of net operating income (NOI) carries more weight. This is all to say that rising interest rates may have some impact on cap rates, but it should not be substantial in the long run – investors can protect themselves against the risk of rising cap rates by pursuing longer-hold projects.
For investors in online real estate (crowdfunding) platforms, the chief consideration should be whether the platform’s real estate team is considering these factors, and whether the originators behind the platform’s constituent projects have experience through business cycles, and can make wise investments and management decisions in a fluid interest rate and regulatory environment.
About the author:EQUITYMULTIPLE is an online marketplace for private real estate transactions. It enables individual and institutional investors to invest alongside the market’s most sophisticated sponsors in many commercial real estate assets. EQUITYMULTIPLE was launched in February 2015 and is based in New York, United States.