Finance Corner: Crowdfunding

Finance Corner: Crowdfunding

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The benefits of real estate investment are well known. Most of the world’s richest people made their millions in real estate. However, entering the real estate sector can feel like a high barrier of entry for some people. They want to buy a property but don’t have enough for a down payment. Or perhaps they have the funds but are unable to perform the duties of being a landlord.

Table of Contents - Finance Corner: Crowdfunding

Tech has an answer for that. For the past few years, crowdfunding sites have popped up across North America, allowing investors to contribute smaller amounts to real estate developments in exchange for a proportional return. Crowdfunding technology connects individual investors with real estate owners to raise equity for projects. With enough crowdfunding, developers, property managers and even private homeowners can receive the equity they need for their project.

A brief history of crowdfunding

U.S. President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act in 2012, which went into effect in 2016. The bill allows non-accredited investors to invest in private companies. Before the bill’s passage, investors had to have accreditation to invest in private companies. Accreditation required having a net worth of at least $1 million or have earned at least $200,000 a year for at least two years.

This important legal change meant that crowdfunding was now a possibility for real estate investment and development. There is a lower barrier of entry for individuals who want to invest a smaller amount of money in real estate projects. Private companies have increased access to a larger pool of investors.

While crowdfunding has proven to be a good investment model so far – returns can exceed 10 percent annually – the industry is still quite young. There is not yet enough data to state how strong of an investment crowdfunding real estate is relative to other models.

Crowdfunding business models

Each crowdfunding investment platform is different, but they generally stick to one of these models:

REITs

Like traditional real estate investment trusts (REITs), these platforms offer semi-blind funds with a selection of properties. These properties could vary by type or could contain one type of property. REITs offer a diverse portfolio and have low minimums for investing.

Commercial equity investing (CRE)

When you think of crowdfunding real estate, you’re likely thinking of a CRE. These platforms offer accredited investors the opportunity to purchase equity in larger commercial projects. These projects have great return potential but tend to be longer-term and riskier.

Debt investing

These platforms take all or part of an existing real estate loan and syndicate it out to individual investors at a fixed rate of return. The rate of return typically ranges between 7 and 12 percent and is paid out over a short term, generally six to 18 months. Other platforms act as the lender and issue a loan to a developer or flipper.

Benefits and risks of crowdfunding

One of the reasons that crowdfunding was previously unavailable to the average investor is because of fears that bad actors would take advantage of novice investors. Investing in publicly traded companies ensures government oversight of the company. Having accredited investors ensure that investors know what they’re doing and can financially handle a loss.

Fortunately, real estate has historically proven to be a stable asset class. While individual investors may not know much about the market, and experienced real estate professionals may have plenty of slick skills to part investors from their money, real estate itself generally remains strong.

Investing in crowdfunding doesn’t require much to get started, so even if an inexperienced investor loses on a deal, the results shouldn’t be catastrophic. For example, someone could invest in a six-figure urban property for as little as $1,000.

Investing in rental properties offers additional returns for investors. In urban markets where apartments are scarce and demand is high, investors can build compound wealth. The investment property is increasing while rental rates rise, increasing investor profits.

What to consider when investing in crowdfunded real estate

As with any investment, it’s best to do your homework before committing your money. Always research the companies you’re considering for your investment. Stick to sectors that you or your financial advisor know well.

Naturally, the risk factor is one of the first things you’ll need to evaluate when considering an investment. Red flags include a weak track record, short construction timelines, a turbulent labour market or aggressive leveraging from the deal’s sponsor. If the deal doesn’t seem transparent, and the platform is unable or unwilling to answer questions, move on from the deal.

You’ll also need to fully understand the payout structure. Debt deals are usually straightforward, but equity investments are more complicated. Find out where your investment fits as it relates to the project capital and how you will be repaid your principal and profits relative to other investors.

It’s important to know how liquid your investment will be. When evaluating a business plan for investment, note whether you receive your distributions monthly or quarterly. Find out whether you will begin receiving cash flow from rent immediately, at a later date or never in case of new development. Read the schedule of distributions and when your principal will be repaid to ensure it meets your personal financial needs.

Finally, you should also consider how the investment fits with your overall portfolio. If you’re interested in crowdfunding because you want to diversify, then a crowdfunding deal that only funds one property may not be worth it. If you’re too invested in one asset class or geographical region, your portfolio won’t benefit.

Real estate crowdfunding is an easy way to enter the real estate investment space or to diversify your portfolio with an alternative investment. Because it’s new, its stability has not yet been proven. Don’t use crowdfunding as your only investment model. However, with enough research, you could find a strong return on investment and an exciting foray into a new type of investing.

Your Guide to Understanding Crowdfunding


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Scott Dillingham

Scott Dillingham

I have been investing and lending to real estate investors for nearly 10 years now. After thousands of successful deals between flips, rent to owns, student properties and commercial assets I have developed a deep knowledge of real estate investments and have a passion of sharing this information with the world! If your looking for a lender who specializes in rental property financing you're going to want to connect with me at team@lendcity.ca.