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. Online Crowdfunding Platform  

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:
 DebtEquity
Type of investmentLender to Property OwnerProperty Owner (shareholder)
ReturnInterest (Fixed)Share of net profits (Varies)
Return PotentialCapped, limited to the loan interest rateUncapped, can be in the double-digits
RiskLowerHigher
Secured byPayback of loan is either (1) secured by the property or (2) unsecured promisory noteUnsecured-You own real estate value after debt
Seniority Default1st to receive payout, but you may have to pay some of the foreclosure costs if loangoes into default2nd to receive payout
DistributionsYes, monthly or quarterly interest payoutsVaries, sometimes quarterly distributions are paid
FeesTypically 2% + possible loan origination feeTypically 1%–2%, no upfront or service fees
Holding periodVaries: 6–24 monthsVaries: 1–10 years
Tax benefitsNoYes, 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:
  1. net worth or joint net worth with the person’s spouse exceeding $1,000,000 not including the value of the primary residence.
  2. 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-FrankOnly local exposure
Too small for institutional investors
Massive fees for REITs
Banks are too slowLower 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.  
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.
  Evolution Of Hard Money Lending Investing   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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Or click the image below: Infographic

The Power of Reinvesting   Reinvesting earnings is a powerful tool that can help investors grow their wealth, thanks to a phenomenon called compounding. Warren Buffett once said: “My wealth has come from a combination of living in America, some lucky genes, and compound interest.”  What is compounding, and why is it so important to investors?  Well, we’re going to dig into that here.

What Is Compounding?

The simplest way of explaining compounding is that you are making returns on top of your returns.  I’ll use a simple example to help clarify:  say you make a $10,000 investment into a bond that pays 8% interest, semi-annually, meaning you receive a $400 payment twice a year.  Now, if you just took the two $400 payments, and assuming you don’t care about price changes in the bond, your return is 8% per year.   Pretty self-explanatory, right?  Well, what happens if you reinvest your first interest payment as soon as you receive it?  Your investing base (the amount upon which you earn interest) rises from $10,000 to $10,400 for half the year.  Now, if we multiply that by 4% (our 8% interest divided by 2 to account for the semi-annual payment), you now earn $416 on your second interest payment.

The Power of Compounding

That extra $16 may not seem like all that much, but here’s the difference that reinvesting can make over time: if you were to simply take the interest payments you received, it would take you 25 payments to double your money, or 12.5 years. If you reinvest your earnings, it would only take you 9 years instead.  If you had been reinvesting for the same amount of time it took to double your money without reinvesting, you’d have made an extra $6,700!

Click on the image to enlarge it.

For investors with a long-term investment horizon, those three extra years can add up.  With an investment horizon of 30 years, you’d make about 9.5 times your initial investment ($95,196.27 in profit), whereas if you just took the interest out, you’d receive less than 2.5 times what you initially invested ($24,000).

Click on the image to enlarge it.

Compounding With Stocks

From an stocks perspective, the S&P 500 returned roughly 79% over the past 10 years.  If we had reinvested dividends, that changes to 123%, and goes from a 6.01% annualized return up to an 8.3% annual return!  (Calculated from 11/20/2007-11/20/2017, Source)

Click on the image to enlarge it.

Compounding is an incredible tool in an investor’s arsenal for growing their wealth.  It’s not just useful to purely income generating investments, but to investments that have occasional cash flows as well.  The growth power compounding can provide is why AlphaFlow offers its investors the ability to have not just their repaid principal, but earnings reinvested as well.    

We’ve included a calculator that you can use to see the power of compound interest!

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.
 

About the author:

Nick GiovacchiniNick Giovacchini is the Client Services Director at AlphaFlow. Prior to joining AlphaFlow, Nick worked for Barclays Risk Analytics and Index Solutions team, working with institutional asset managers to analyze risk and performance drivers of their portfolios. He also was an Account Manager for MarketFactory, a leading technology provider for the FX world.

Nick has a BA in Political Science from George Washington University in Washington, DC.

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  Robo-Investing   The robo-investing and the robo-advising market keeps growing here and around the world. Here are some recent news stories in our market.

Not Just for Millennials

Canada’s Globe & Mail reports that the average age of the Canadian robo-investing client is 44 years old. In the U.S., 48 percent of clients are over 36 meaning they are Generation X and older. One of the Canadian robos, Responsive Capital Management, has an average client age of 50, highest of the 14 operators in Canada. Our Take: This is no surprise to us as we have clients across different age groups and, other than being accredited investors, they are a pretty diverse group. With Gen X so familiar with technology, we expect they would like the robo-investing platforms. Millennials like robos too, as this Schwab piece looks at a poll where 54% already use a robo-advisor and up to 25% more would be willing to do so.  

Aviva Goes Robo

Aviva Investors Logo   Aviva bought a majority stake in British robo-investor Wealthify. CNBC reports the Welsh startup targets millennials for ISA investing,  the UK equivalent of an IRA here. Aviva, whose primary businesses are insurance related will integrate Wealthify into their MyAviva app. Our Take: We will see more of this where well capitalized traditional finance companies like an insurer partner with a robo-investor firm for their mutual benefit. We expect to see separate formalized partnerships as well as acquisitions and direct investments like this. The robo gets capital and a new customer base and the insurer gets a new line of business and better technology for their customers. A win/win.  

Blooom Hits $1 Billion Assets Under Management

Bloom Logo   Our friends at Crowdfund Insider report that robo-advisor Blooom now has $1 billion in assets under management. The Kansas firm got to $1 billion sooner than Betterment and nearly matched Wealthfront in time to this important milestone. The company charges $10/month for the management of 401k or 403b accounts. Our Take: The power of technology along with not being caught up in traditional old-line thinking allows robo-investors to do more with less. It’s a great accomplishment that a firm that targets the ‘traditionally unhelped’ is able to get so many assets to manage so quickly.  

Banks Investing in Robo Internally

Bloomberg reports that banks are getting into the robo market. Morgan Stanley, Chase, and Goldman are all looking at ‘digital enhancements’ to their wealth offerings aka robo-investing. While fintech and direct bank investments are growing, funding for startups is down 49% from Q2 according to a CB Insights report. Our Take: We’ve seen banks and robos, and all of fintech, work together in one of 3 ways: Build, Partner or Buy. The Aviva story is a buy and this one is about those looking to build. Some will be successful at building from within and others will go the partner or buy direction. Banks are using their big capital advantage to enter the robo-investing market.  

Is the Largest Robo-Investor Getting TOO Big?

It’s easy to think of Robo-investing as a brand new innovation to finance and there are many firms that are new and innovative, including what we do here at AlphaFlow. However, there’s one firm that has been doing robo-investing since way back in 1976: Vanguard. Their index funds are passive robo-investment. They’ve been so successful at it that they have a new problem. Are they too big? Vanguard’s legendary founder John Bogle thinks the company may be too large. This ThinkAdvisor piece is an interview with Bogle where he talks about how mutual funds have specific concerns on how much stock they own thanks to the Investment Co Act of 1940, although Vanguard owns only 2.4% of their largest holding, Apple. Our Take: None of the fintechs in our space have been around long enough or are large enough to become potential victims of our own success like Vanguard. At 2.4% ownership of Apple, there is still room for them to grow before ownership stakes are too large or they are able to move markets with their decisions. Vanguard’s low fees, service, and growth in AUM are a testament to the success of robo-investing at the stock index level.   An Introduction to Online Real Estate Investors: Who They Are and What They Want   By: AdaPia d’Errico The private lending industry has benefited from several years of growth in bridge financing with fix and flip, purchase, refi, and, more recently, single-family rental financing. While this growth has brought significant institutional capital off the sidelines, another group of early-adopter investors had already been making an alternative play in private money lending and investing through online real estate crowdfunding platforms. A traditionally private industry, as the name implies, lenders and capital investment companies could not rely on general solicitation and advertising due to private placement rules dictated by the SEC through Regulation D, Rule 506(b). Then, real estate crowdfunding came along and flipped the industry on its head. Crowdfunders leveraged Rule 506(c) and took a decidedly different approach to acquiring investors. They created a user experience akin to e-commerce purchases and applied visual merchandising to present deals. Then, they simplified the process of obtaining investment information (and documentation) making it entirely digital, mobile, and available 24/7. Having launched a real estate crowdfunding platform in 2014, I realize that what I consider standard regarding targeting an audience and acquiring clients is not the way it is done in private lending. For example, online community development, social media, brand activation, and digital marketing—these are the elements that form the backbone of reaching people who interact online, whether they are digital natives or baby boomers. We are all part of the “connected generation,” and we all use the Internet to inform hundreds of daily decisions. Beyond the user/client acquisition phase, there are far deeper criteria for engaging with people who may be interested in investing in real estate online. One must understand online vs. offline behavior, expectations, and requirements of a potential client. Decoding the potential investor’s mindset, which may be fraught with well-founded and well-researched concerns, solving for UX (user experience) and CX (customer experience) pain points, and earning trust with a website and strategic content are elements used by the most successful online real estate investment companies. The number of people investing online and including real estate as part of their investment mix is growing. In the recently published 2017 ‘The Americas Alternative Finance Industry Report,’ research shows that Real Estate Crowdfunding (RECF) increased by 70% to $821.0 million in 2016 from the $483.8 million in 2015. Over the three-year period, RECF saw an average annual growth rate of 160%, and it accounted for 2.3% of the total market in 2016. The naysayers have been proven wrong. Why are investors interested in online real estate opportunities? For most private investors, real estate crowdfunding platforms offered the first opportunities for many people to invest directly in real estate as an asset class without writing a six-figure check. That meant few people truly had access to real estate investments, particularly if they did not want to make it a full-time job. Platforms like Patch of Land and RealtyShares, which was co-founded by AlphaFlow’s CEO, Ray Sturm, changed all that by letting people invest as little as $5,000 in great projects from all over the country. AlphaFlow itself purchases loans from private money lenders and online origination platforms to build personalized portfolios for private investors. Below are some insights from our experience and our growing clientele. What are the some of the most common investor concerns? Many private investors are venturing into real estate investing for the first time. Their biggest concerns typically revolve around understanding investment risk and possibly feeling overwhelmed by the complexity of investing in certain real estate structures. When deals get too complicated, with multiple types of equity and complex rules and tax situations to map out how they get paid, new investors tend to pull back and wait for a simpler deal. It is one of the reasons first-lien debt on residential real estate has worked so well. The deals with clear value propositions, transparent risks and easily understandable timelines and return calculations tend to fund most quickly. What makes investors uncomfortable? Investors will also have a healthy dose of skepticism about investing in real estate if they have never done it before. There is also negative nostalgia around real estate due to the housing crisis and both the real effects felt by so many people and the effects that media has added to the national psyche, most recently with the films, ‘The Big Short’ and ‘99 Homes’. Also, there is discomfort around investing with a new, unknown company. Building trust with a potential client is the number one prerogative of an investment manager, or any company raising capital. What are the online investors’ preferred investment duration and rate? New investors—and that may mean investors new to real estate investing or new to an investment platform—typically look for investments with a 12-18-month duration. Once they make a few of those investments and see their payments arriving on time, they have a positive experience and begin to think longer term. They may be happy with their returns but not necessarily interested in repeatedly finding new deals in which to invest because of the burden of time required to do thorough due diligence on each project, and on multiple sites. This nascent space commands a considerable risk premium from private investors, and in the first few years, many deals (debt or equity) paying less than 9% would languish. However, the last few years has taught many investors that projected returns are not necessarily going to match actual returns every time, particularly with risky equity deals. The result is a shift by investors to include first lien debt in their portfolios, in addition to better understanding the risk-return profile, especially as it relates to LTVs, judicial vs. non-judicial states, and local market factors. Are investors’ risk/reward expectations reasonable? A philosophy shared by experienced investors is that you can be a successful investor and incur defaults or losses as long as you have a diversified portfolio to minimize the impact of any single problem investment. Diversification includes a mix of different types of investments within each asset class of your portfolio and a solid mix of asset classes. In online real estate investing this includes diversification across platforms, borrowers, and geographies. What are the demographics and experience levels of online real estate investors? In the early days when crowdfunding platforms first emerged, a high percentage of customers were experienced real estate investors. They viewed the platforms as another avenue to access opportunities, particularly in attractive MSAs far from where they lived or typically did business. Because they knew how to evaluate opportunities and projects, they could make investment decisions using the information provided by the platforms, and to further diversify their investments geographically, without the need to make a trip to the property location. In addition to this group, we have identified two other groups who are regular investors. The first group is made up of highly educated professionals like doctors, lawyers, and engineers who meet the significant income required by SEC regulations but lack time to make these investments on their own. This group is attracted to a passive income and an easy way to access investments, without a significant commitment of time or expert knowledge. The second group is made up of successful small business owners who, like many real estate business owners, may have started out with their own small, local business and grown that over the years, and with it, their net worth has increased substantially. This group understands and is attracted to the tangible nature of real estate. Do investors need to speak to someone at the platform? Are they happy to invest online with no interaction? Many investors are happy to work with platforms electronically, but they often want to kick off the relationship with a conversation. Investors, both those who are unfamiliar with real estate investing and those who have been doing it for years, have many questions and want to speak to ‘real’ people. They are prudent, sometimes skeptical and very smart. They are vetting the professionalism, experience, and expertise of the company, whether they speak to a founder, a VP or a client services employee.  While a seamless experience, engaging online presentation, and thorough project information are vital elements to success, investors are seeking to vet the people behind the platform to build a level of comfort and trust before investing their money – no matter how attractive an investment may be on the surface. How important is investor communication and what does an investor expect? Clear and honest communication is critical to building long-term relationships with investors. It is especially important when communicating the progress of a project, repayment of loan interest and principal, including delays in payments, extensions, and foreclosure proceedings. One of the reasons online investing is being adopted is that platforms have made it easy and accessible for investors to ‘see’ and evaluate a deal without needing to go on-site to see it in person, or meet the borrower or sponsor. The investor trusts the platform and the deal that is being presented for investment. However, the platform is also responsible for maintaining consistent and transparent communication about the returns ‘promised’ to the investor by way of regular updates, especially when returns do not match stated or expected payments. If an investor does not receive those updates, or cannot easily obtain progress reports, accurate payment calculations, or is unable to reach someone at the company, their worst fears kick in. Any miscommunication, misinformation or lack of communication creates a situation in which investors cannot wait to get their money back and invest it elsewhere. Given the cost of acquiring customers in the space, that is an expensive mistake. What percentage of investors are completely new to real estate investing – online or traditional? Today, we estimate that about 70% of customers have never invested in real estate before working with AlphaFlow or one of the real estate platforms. Also, as we have seen from the research mentioned above, the figures for dollars invested and participants in crowdfunding is growing, but the industry still has not penetrated beyond a relatively small number of early adopters. There is still a large opportunity for reaching the individual investor at scale. Growth in online platforms has opened private lending and investing to a broader audience. Most investors doing real estate investing online today would not have found their way to a private lender or private capital company. Understanding the nature of online behavior, and investor requirements and expectations is a key factor in converting interest into investment. However, we cannot discount the importance of active relationship management both in earning an investor’s trust, as well as building long-term relationships based on fundamental business practices and communication. This article originally appeared in the July-August 2017 edition of Private Lender Magazine.  

About the author:

AdaPia d’ErricoAdaPia is the COO at AlphaFlow. Previously, she was Chief Marketing Officer at Patch of Land, one of the first debt-focused real estate crowdfunding platforms. She co-founded two previous businesses and has served such companies as Disney and Mattel in brand development and online audience engagement initiatives. AdaPia is an active real estate investor and is currently doing a complete renovation of her home.

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