Real estate crowdfunding generates higher returns for investors, however, it has certain risk factors. So before investing in real estate crowdfunding you must be aware of its pitfalls. In this blog, we will discuss the risks of real estate crowdfunding.
Why do you choose Real Estate Crowdfunding?
Real estate crowdfunding is an appealing investment option for various reasons given below:
- The investment involves professional management. So, individual investors who are limited partners don’t have to directly manage the property.
- You choose the specific investment opportunity you want to invest in knowing the sector, geographic market, and asset your money is compared to where your money is spread across multiple investments across many geographic real estate markets.
- Many crowdfunding investments offer higher-than-average risk-adjusted yields.
Real estate crowdfunding is an enticing choice for investors. But there are certain risks of investing in real estate crowdfunding.
Risks of Real Estate Crowdfunding
Like other investment opportunities, crowdfunded real estate investment has some major drawbacks. As a real estate investor, you need to weigh these risk factors while keeping in mind your personal tolerance for the desired return. Let’s have a quick look at the risk factors of real estate crowdfunding websites and platforms.
1. More risks than other investment opportunities
Real estate investments always generate returns with risk. The market suffered a lot during the pandemic. Like any investment not guaranteed by the federal government such as bonds, there is always a chance to face a loss on the invested capital. But you can reduce your risk in crowdfunded investments by applying a few strategies, like creating a diverse portfolio and performing rigorous due diligence on any potential investment.
2. Crowdfunding platforms can risk investments and may suffer from platform failure
Crowdfunding investments are not secured under the same terms and conditions, and this exposes investors to risks from platform failure. It occurs if the crowdfunding sponsor mismanages investor funds. But you can protect yourself from failure by properly vetting your sponsor and doing the deal with an established, well-respected crowdfunding platform.
3. New investors may face problems with crowdfunding investments
Crowdfunding is a completely new way of investment and several investors face problems with its digital nature. But the investors who are unfamiliar with the old fundamentals of traditional real estate business find it easy to access the crowdfunded platform.
Unfortunately, there is not much you can do to prevent this; it happens with any type of investment that achieves popularity, including stocks, tech startups, precious metals, and other commodities.
But you can also protect yourself from risks in equity investing or debt investments for the long term via such platforms through due diligence and research. As a result, you can know how an investment is going to generate returns for your portfolio.
4. Limited due diligence
Digital platforms make the search easier for potential investment and connect with crowdfunding sponsors. But the financial research and analysis industry has not gone to those heights of digitalization and to this new way of funding development projects.
Resources for vetting potential projects are limited especially when compared to the numerous reports and analyses made for equity and commodity investments. Investors who do not want to rely on someone else’s opinion give them a chance to research their project on their own.
And some of them do not want to dig into financials, market reports, and other data points that help them to make an informed decision.
5. Crowdfunding is treading new regulatory grounds
Every time you have a paradigm shift in finance, tech, and other economic sectors it seems that regulators and authorities are running to catch up with the deal. While not having a clear idea of the defined rules and regulations can lead to many problems. In addition to this if the government pokes its head into the plate then it can present significant problems for the investors.
This may also introduce risks into the crowdfunding platform from which the investors should be aware.
6. The success of the investment is in the hands of the sponsor
The sponsor is the person who regulates the total investment process. The viability and profitability of the investment depend on the sponsor and its management team. Before selecting you must go through the sponsor’s track record and how many assets they own and manage.
But success is in the hands of the sponsor, so you must not be satisfied with crowdfunding. So it totally depends on you and your comfort level. So before investing make sure you agree with the sponsor’s investment plans and management strategies.
7. Low Liquidity
Liquidity is one of the most important parts of investing in commercial real estate, where you can invest or withdraw your money at any moment. But in real estate crowdfunding, the liquidity is comparatively low. It requires at least 2 years before you can have your capital returned.
And if you want a good return then you have to keep it for several years. The lack of liquidity is one of the reasons real estate crowdfunding platforms often provide higher returns than traditional ones. But if you are concerned about liquidity then you can go for the traditional form of real estate investing.
8. There are no guaranteed returns
There are no guaranteed returns in crowdfunded investments. There are always negative factors that affect the performance of the investment such as market fluctuations and construction setbacks. Crowdfunded investments may not reach the projected target.
This reduces the dividend return to the investor providing a lower-than-anticipated yield. Many worst things can occur such as investment might fail, the sponsor could file for bankruptcy, and the asset might go through foreclosure.
Depending on the circumstances the sponsor may not be able to give the interest or principal. So, you have to be comfortable with that before investing.
The Lilypads Bottomline
So to get started with crowdfunded real estate you must take the knowledge regarding the various risk factors from this blog, and add some hard work and due diligence to avail the immense possibilities provided by this investment. You also have to be cognizant of the pitfalls and risks that come with this unique form of investment.