According to marketing gurus Statista, The Crowdfunding segment across the globe is projected to reach a staggering US$1.29bn by 2027.
So it’s not surprising that many entrepreneurs are looking to add to their real estate portfolio through crowdfunding.
Our crowdfund platform experts here at Fundraising script have put together a guide to real estate Crowdfunding for beginners. So join us as we give you the lowdown on what you need to know.
We will cover, what is crowdfunding, the pros and cons, and regulations, and discover the two types of real estate crowdfunding, plus best practices.
So to get started, let’s take a brief overview of what it is and how you can benefit from crowdfunding real estate deals.
What is crowdfunding?
In its simplest terms, real estate crowdfunding is a type of property investment where many investors or ‘crowd’ pool together their funds.
Once the funds have been gathered, they are then used to buy a property or given to developers as a loan to finance a property development.
Usually, the investors only contribute a portion of the amount required to purchase the real estate.
A quick way of raising funds to purchase property
It’s an incredibly quick and efficient way of raising the types of sums necessary for buying property.
So if you are looking at starting a crowdfunding
Also, it means that investors can have a stake in property with a smaller amount in deals they wouldn’t have access to using other methods of raising funds.
Once the real estate has been purchased, any returns are divided equally among the investors.
So what do you own if you use crowdfunding for real estate?
Read on to discover more.
What will I own?
There is quite a wide variety of how each crowdfunding platform structures investments and of course, this will affect what the investor will own.
It may be that some real estate software platforms will create a separate company in terms of an LLC ( Limited Liability Company) for each property deal.
The LLC holds an interest in the entity that owns the real estate at the centre of the investment.
Any investors will then hold shares in the LLC, which results in limited liability alongside some tax benefits that are usually associated with pass-through entities.
Payment dependant notes
When you invest in debt or certain types of preferred equity, you’re actually investing in notes that are linked to the success of a real estate loan or project investment.
Crowdfunding platform subsidiaries make these investments. You own the note and if the venture does well, so do your earnings.
There are two ways of raising real estate funds using crowdfunding.
The first is property equity investment. This is generally rental income on any real estate purchase and includes the capital generated by the value of the property.
The second is a property-backed loan investment where you effectively ‘loan’ the funds to the developer.
So let’s find out a little more about these two types.
By using the equity investment method of crowdfunding for real estate, investors essentially become shareholders.
By choosing this type of real estate crowdfunding, your returns will be calculated on the rental income of the property. With any crowdsourcing fees calculated at this point and paid.
In general, this is the way most real estate crowdfunders conduct their property deals. This is because it usually has a higher return than simply debt investing.
Pros of equity investments
When the property is sold another benefit of this type of investment is that investors will also earn shares in the property’s appreciation.
With this type of investment, you can often see a very profitable return. Often it can be as much as 20 – 25%.
In some cases this can even be more due to the fact equity investments aren’t capped. These payouts are usually paid quarterly.
Cons of equity investments
So although equity investments can offer higher returns it’s worth knowing that if there is no profit gained on the property, you will fail to get any return on your investment.
It’s also worth understanding that you will also be second in the queue for payouts.
There is also a longer holding period for this type of real estate crowdfunding whereby the holding period is usually between five to ten years.
The main difference between debt investing and equity investment for property crowdfunding is that you are essentially the lender to whoever owns the property.
Pros of debt investing
The way this type of real estate crowdfunding works is that you will get a fixed return from the amount you have invested, alongside the interest rate of the owner’s original mortgage loan.
In this type of investing, you will take priority in any payouts with payments usually arriving monthly or sometimes every quarter.
Cons of debt investments
As debt investments are worked out based on the owners’ specific mortgage interest rate on the loan. So for this reason, any returns will be limited.
When using the debt investment method of real estate crowdfunding the platform will often take a percentage of your payout. So make sure that you do your research thoroughly.
Ok so now seen some of the benefits and the downsides of each type of investing, you might be wondering how real estate crowdfunding is regulated.
How is crowdfunding regulated?
In 2012 The JOBS or Jumpstart Our Business Startups Act changed crowdfunding regulations.
Before this, it was far more difficult for investors to advertise their opportunities.
However, since the changes, investors are able to advertise directly to much larger audiences via a variety of methods, including social media and other online methods.
This change allowed investors to gain crucial access to far more funding sources for property deals.
So as with every type of investment, there are risks involved and also important factors to keep in mind. Let’s take a look at a few below.
Best practice when crowdfunding real estate
Before diversifying into the unique world of real estate crowdfunding, follow our tips to make sure you have everything covered.
Keep a close eye on the risk
Diversifying your real estate portfolio is always a benefit but along with the benefits, there are always risks associated with any type of investment.
As we’ve seen above, there are differences between the two types of investing, so make sure you carefully weigh up any potential risks to determine whether debt or equity investing is right for you.
Understand real estate liquidity
It’s crucial for any investor to understand how long they will be locked into a property deal using crowdfunding. So it’s vital to ensure you are fully aware of those details before making any decisions.
It’s worth understanding that each investment has its own specific liquidity schedules and length of time for paying out on any returns.
Liquidity is essentially the trade-off between the price at which an asset can be sold and the speed at which it can be sold.
Take control of your investment
Before getting involved with any real estate crowdfunding platforms for investment deals it’s crucial to understand they are not investment advisers.
However, some of the best real estate crowdfunding platforms will vet each deal before giving investors the opportunity to take part in the deal.
It’s always worth enlisting the advice of a fiduciary or financial advisor before going ahead.
Getting control of your investment is important and you may be comparing it to other ways of real estate investment.
Find out more about how crowdfunding stacks up against private equity funds in our other helpful article.
Research platforms vigorously
One of the first things for any investor to do is perform due diligence on the crowdfunding software platform they are looking to use.
Some of the most crucial factors to consider are
- How many deals the platform has worked on
- How long the business has been in operation
- What kind of returns the platform has delivered
- The funding of the platform
- How credible is the management is
- Overall track record
It’s worth understanding that each platform has its pluses and minuses so for that reason, some may be a better fit for you personally.
To find out more about crowdfunding software check out our other helpful article
And to end on…
So we hope that’s given you some background, hints, and tips on the basics of building your real estate portfolio using crowdfunding.
So where do you start?
Using our innovative Crowdfunding software we offer a fully customized Real Estate Crowdfunding platform for entrepreneurs to add to their websites.
We offer a space for developers to list their projects and invite crucial investments to scale your real estate empire.