Learn the Pro’s and Con’s of Real Estate Crowdfunding

Advisor September 3, 2019

A lot of people are not well aware of real estate crowdfunding, but this concept is rapidly growing among the investors. Basically, crowdfunding is doing for real estate investment what Lending Club or Prosper does for personal loans. They act as online peer-to-peer marketplaces which help in matching investors with borrowers, often under better financial terms than what they can get through the traditional lending institutions, such as banks.

People investing on an idea

So, What Exactly is Crowdfunding

Real estate crowdfunding comprises of various online platforms. There, real estate developers come for raising cash – either through the equity investments or by debt financing – and investors come to invest funds in those projects. They work as –peer-to-peer– investment sites, connecting those who need money with those who have it to offer.

The platforms are basically used by the individual investors. But, they are also growing more popular with the institutional investors, like banks and insurance companies.

Since they eliminate the “the banker-middleman”, real estate crowdfunding platforms can offer investors the higher rates of return on their capital. And at the same time, they can also charge a lower interest rate to real estate developers. This creates a win-win situation for both parties, and this explains the growing demand for these sites.

Loans and equity can be secured on the projects which range from single-family homes to large apartment buildings and also retail shopping centers.

The Benefits and Drawbacks of Real Estate Crowdfunding

Real estate crowdfunding gives a large number of benefits. These include:

Investment diversification. If your present portfolio holds mostly bonds, stocks, and funds —i.e. all “paper assets” — then you can benefit from adding the hard assets such as real estate to the mix. Because of the nature of real estate investment, the returns could be higher than what you can receive on fixed income investment while being less volatile as compared to stocks. Meanwhile, real estate is also famous for being the excellent inflation hedge.

Invest in different types of real estate. Crowdfunding platforms let you diversify your real estate holdings among different types of properties. For instance, you can spread your capital across apartment buildings, retail shopping centers, or hotels. You can even diversify geographically. Instead of investing in a single real estate project in your hometown, you can invest slices of your money in different cities.

Small initial investment. You can invest in most of the real estate crowdfunding platforms with a little amount as $5,000. Since individual investments can be taken with the minimum amount of $1,000, your initial investment can be diversified across several different projects.

More control than what REITs offer. While there are similarities between real estate investment trusts (REITs) and real estate crowdfunding, crowdfunding lets you directly control the specific project you have invested on. You can even invest in a single family, local, fix-and-flip projects. However real estate crowdfunding isn’t without the drawbacks either. Some of them are:

Capital Calls. Due to the complexity of real estate projects investment can require more capital than you originally anticipated. In such situation, the project manager shall issue a capital call, which is a request from the investors for an additional capital. You should be aware of such possibility on any investment you’re going to make.

You must typically be an accredited investor. Accredited investors have definite income and net worth requirements which generally exclude small investors. And that is the basic point. Since the real estate investment is a complex process, you must be a sophisticated investor with high net worth. This can help you understand the risks of the investments, and be able to absorb the potential losses.

Investments aren’t liquid. Real estate investments tend to be long-term in nature, and are not traded on the national exchanges. Once you have committed money to some investment plan, you will usually be required to remain invested until it gets mature. The platforms themselves don’t offer a secondary market to sell out your investment, either.

Your investment isn’t guaranteed. Although you can make greater investment earnings, you can also lose your initial investment as well. This makes the real estate crowdfunding a high-risk investment. It should not be taken in the same terms as the bank investment.